Understanding the variation in volatility

It has been over four years since the Investment Association launched the Volatility Managed sector. Its goal, according to its capital markets director Galina Dimitrova at the time, was to “reflect the advent of more results-oriented products.”

Today, the sector is popular with financial advisers and retail investors. It averages over £ 250million per month and is home to funds managing over £ 50 billion in total. In the 50 months that have passed since the launch, only one (March 2019) has experienced negative flows.

However, with funds adopting different investment styles and underlying holdings often indistinguishable from a traditional multi-asset approach, how can advisors navigate the industry to meet client needs?

2008 and all that

The birth of results-based funds can be attributed to the global financial crisis of 2008/9, when unforeseen and severe market volatility resulted in huge losses for investors.

In this context, an appetite for funds which had a better chance of offering investors both an acceptable investment trajectory and a satisfactory result appeared. This heralded an influx of funds that focused, not on asset bands, but on risk metrics and variations in return.

The evolution of Volatility Managed

From day one, funds in the Volatility Managed sector have varied in terms of their approach and style of investing.

That was in 2017, and the industry has evolved since then.

The managers’ initial approach was to target a percentage of the historical volatility of an index – 50% of MSCI World, say – with a perimeter on either side. However, the downsides of only evaluating past volatility quickly became clear – consider, for example, the wild swings in the markets at the start of the Covid-19 pandemic. In short, recent history has taught managers little about how returns vary during investment periods, and it is telling that few funds use this approach today.

Next, it was a matter of considering the expected variations in returns over the lifetime of an investment using (at the time) modern statistical methods. The combined forecasts of the future volatility of individual assets were then used to construct effective portfolios, which further benefited from the rise of stochastic modeling.

From there, the managers’ attention shifted again, this time from the journey to the bottom line. Today, advanced statistical techniques are used to simulate a “better” return on investment and then try to reduce the variability of the results. This is where the investor’s time horizon becomes important for the asset mix: after all, some assets such as bonds can be volatile over their lifetimes but offer some degree of certainty about results.

If you are looking for an analogy to explain this approach to customers, you can use the dart board. When a dart is thrown, it will wobble while flying (if you’ve ever seen a dart fly in slow motion, you’ll know what I mean). It reflects a client’s investment journey. However, when the darts hit the board, they rarely hit the same spot, but are spread out (especially if like me you’re not that good). This illustrates the dispersion of investment results.

60/40, evolved

The differences between a volatility managed fund and a traditional 60/40 portfolio may not be obvious, at least on the surface.

You will find similar asset classes including property elements and commodities. You will see tactical asset allocation strategies superimposed on strategic allocations. You will find that both approaches face similar challenges, such as responsible investing, assets versus liabilities, and the effects of interest rates and inflation.

However, the advantage of Volatility Managed funds lies in their focus on investment journeys and results. This allows advisors to offer an investment solution that benefits from the expected investment efficiency and that can be adapted to clients’ risk profiles in the medium and long term.

How to navigate the volatility management industry

Join us for a live webinar where we will discuss the evolution of the volatility management industry and share our tips on how advisors can assess the funds therein and choose the best ones for the market. customer situation.

The webinar – Through the Maze: How Advisors Can Navigate the AI ​​Volatility Management Industry – takes place on Tuesday November 16 at 11 a.m., in partnership with Professional advisor. Sign up for free here.

About Larry Noble

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